Monday, April 21, 2014

Thomas Piketty has written a big data-driven book and an
important book about the growing unequal distribution of wealth and income in
advanced capitalist societies. However, never once does he mention in his 685
pages why rising inequality matters. For Piketty it is a given. Although
Piketty is not a Marxist he wears his social democratic identity on his sleeve
with such a statement as “the evil genie of capitalism will be put back in its
bottle.” (P.350) To him the 1914-1970
period where income inequality was on the wane was a brief hiatus between the
Gilded Age and Belle Époque of 1890-1910 to what he perceives as the new gilded
age of today. After all from 1970 to 2010 the share of income going to the top
1% of the income distribution increased from 9% to 19.8% in the United States.

What interests Picketty is what a Marxist would describe as
the laws of motion of capitalist society. For Picketty it is the concept that
the pure return of capital (r) is greater the overall economic growth rate
(g). He demonstrates that the pre-tax
real return on capital is roughly constant approximating 5% and in most cases
economic growth is well below that. For him there is no falling rate of profit.

In order for capital to grow faster than income both the tax
rate on capital income (dividends, capital gains, interest and rents) and the
propensity to save has to be low. Otherwise the retained return on capital
would fall to or below the growth rate in the economy. Thus as long as the
retained return is above the growth rate of the economy the capital/income
ratio increases faster than the economy and the share of income derived from
capital rises. And here is the punchline because capital is more concentrated
than wage income; income inequality has to rise over time. This notion explains
English and French inequality, but unfortunately it is not a good explanation
for what has happened in the U.S. where the labor income of the top 1% has exploded.

Returning to the history, income inequality significantly
declined from 1914-1950 and then stabilized for another 20 years. Why did this
happen? Answer: two very destructive
wars and a depression. Simply put capital (and millions of lives) was destroyed
and the income from it disappeared. Along the way tax rates sky rocketed and
growth collapsed. Similarly during the Great Recession of 2008-09 inequality
was reduced as stock prices and real estate values crashed. Unfortunately the
collateral damage on the average worker was far greater than it was for the
owners of capital. Witness the more than complete recovery in stock prices and
wages for the top 1% post-2009 while average wages have stagnated. The cure was
far worse than the disease.

Although Picketty denies it, the laws of motion in the
United States differ from Europe. Here as Picketty notes we have witnessed the
rise of the super-manager who has captured an increasing portion of labor
income. The share of wages going to the top 1% increased from 5.1% in 1970 to
10.9% in 2010 accounting for half the gain in their total income share over
that time period. I would argue the wage share gain is far greater than that
because in the late 20th Century and in recent year’s human capital
is monetized into financial capital. The return to Bill Gates’, Mark
Zuckerberg’s, Sergey Brin’s human
capital comes not only from their
salaries and the ordinary income that comes from the exercise of stock options,
but also from their initial ownership positions in the companies they founded.
For example according to the Forbes 400 list the wealth of such corporate
founders amounts to $72 billion for Microsoft’s Bill Gates, $41 billion for
Oracle’s Larry Ellison, $27 billion for Amazon’s Jeff Bezos, $25 billion for Google’s
Larry Page, $19 billion for Facebook’s Mark Zuckerberg and $7 billion for
Tesla’s Elon Musk. Is this the 19th Century wealth of an Andrew
Carnegie or a John D. Rockefeller whose assets were tied up physical plant? I
think not. In the new world of capitalism intellectual property is valued more
highly than physical capital.

Moreover Picketty’s 19th century view of capital
is the role of real estate in national wealth. Real estate holdings accounted
for more than 60% of French capital, more than 50% of British capital and more
than 40% of U.S. capital. True it not the landed wealth of the 18th
century, but it is the 21st century urban version of it. This is important because if Picketty is
really serious about equalizing the distribution of wealth he would advocate a
radical reduction in the planning constraints that artificially increase real
estate values in the great urban centers of New York, London, Paris, Los
Angeles, San Francisco and Washington, D.C. It would be far more beneficial to
do that than to impose income tax rates of from 60% -80% on the top 10% and the
progressive wealth tax he advocates. While higher tax rates on capital would
arguably reduce economic growth, an easing of planning constraints would
increase it. I know Picketty would argue that the post war economy grew rapidly
in during the postwar era in regime of high tax rates. That is true, but much
of the growth came from a recovery from the depression and World War II. Recall
that, although high, the tax burden dropped from its war time peaks.

All told Thomas Picketty has written a book that is and will
continue to be much discussed. It should be the subject of serious debate and
readers should note that the book is not an all-encompassing treatment of
inequality. He ignores the role of assortative mating at the top where, for
example an investment banker marries a corporate lawyer, and the role of
single-parent households at the bottom of the income distribution. But any
economist who quotes Jane Austen and Honore de Balzac has to have a lot going
for him.

About Me

David Shulman is a Distinguished Visiting Professor at Baruch College where he mentors students seeking front-office careers on Wall Street, a Senior Economist at the UCLA Anderson Forecast and was a Visiting Professor at the University of Wisconsin. He retired from Lehman Brothers where he was Managing Director and Head REIT analyst. From 2001-04 he was voted on the Institutional Investor All Star Teams including First Team in 2002. Prior to joining Lehman he was a Member at Ulysses Management LLC (1998-99).
From 1986-1997 Mr. Shulman was employed by Salomon Brothers Inc in various capacities. He was Director of Real Estate Research from 1987-91 and Chief Equity Strategist from 1992-97. He was widely quoted in print and electronic media and he coined the terms “Goldilocks Economy” and “New Paradigm Economy.” In 1991 he was named a Managing Director and in 1990 he won the first annual Graaskamp Award for Excellence in Real Estate Research from the Pension Real Estate Association.
A graduate of Baruch College (1964), Mr. Shulman received his Ph.D. (1975) with a specialization in Finance and a M.B.A. (1966) from the UCLA Graduate School of Management.